04 June 2012

FASB Chairman Leslie F Seidman: Disclosure overload in financial reports and cost-benefit analysis

Ms Seidman spoke about two major issues - the disclosure overload, and the analysis of costs and benefits in standard-setting, including the consequences of accounting standards, that now confront the FASB.

Ms Seidman started with the issue of disclosure overload, which is one of the most common concerns that are dealt by all types of stakeholders, from investors to auditors of micro-companies all the way up to the C-suite at major companies. Many of those stakeholders consider financial reports as just too long—and, as a result, that they have become much less effective tools for communicating with investors. Yet investors continue to say they want more information, particularly when there is a business downturn or failure. Often the information that these investors want is available in the financial statements—but it is hidden in plain sight.

The FASB has taken an ad hoc approach to disclosure. In areas, such as a company’s revenue, there are very few GAAP requirements. Yet, in other areas, the FASB has gone into great detail, requiring very specific information about a cost accrual that might be relatively insignificant, in the grand scheme of things.

Over time, the FASB also has taken an ad hoc approach to establishing disclosure requirements in interim reports. Finding the right balance between the investor’s needs and the preparer’s constraints is a recurring issue in discussions.

Another issue contributing to “overload” is that, in some areas, FASB requirements overlap with SEC requirements. Sometimes that’s because the FASB information is historical and the SEC requirement is forward looking.

A contributing factor is the “checklist” mentality of some companies and their auditors. When immaterial or unimportant information is given as much prominence in financial reports as important information, investors find it much more difficult to identify the information that provides insights into the trends, risks, and prospects of the company.

Many people struggle with how to apply the concept of materiality to disclosure items. If an item is material in a financial statement, must every prescribed disclosure about it be provided, even if some of that information is immaterial? On the other hand, can a preparer afford to omit immaterial information when they are likely to spend more time explaining to an auditor, investor or regulator why it was omitted? Ms Seidman calls this phenomenon “defensive disclosure.”

Disclosure overload is clearly a problem and that is why the FASB has been working to develop a disclosure framework that it believes will improve the quality of the information being disclosed and will make financial statements more understandable for investors and other users.

The purpose of this project is to improve disclosure effectiveness, not to reduce single-mindedly disclosure volume, and it will address three different areas that could affect disclosures, both in the present and the future.

• First, the framework will help the Board establish consistent disclosure requirements that focus on what is most important to most users.
• Second, the framework will explain how the reporting entity should evaluate which disclosures are needed under different circumstances at different times—in other words, it will lead to a more dynamic approach to providing disclosure.
• Third, the framework will explore ways to emphasise the more “newsworthy” information and ways to make it easier for users to find the information that they are most interested in.

Once the FASB has confirmation on the basic elements of the disclosure framework, the FASB plans to undertake a review of existing disclosure requirements.

The second issue at the FASB which Ms Seidman focused on was—the analysis of costs and benefits in standard setting.

Financial reporting can have economic consequences. One consequence is the economic growth that is fostered by efficient markets and confident investors who have the information they need to wisely deploy their resources. Another is the lower cost of capital that results from credible and consistent financial information. Yet another is greater corporate accountability that results from financial reporting that is transparent to investors.

For the FASB, cost-benefit analysis is not a discrete exercise. From Seidman's perspective, the entire FASB process is one big cost-benefit analysis. That is, every step of the FASB's due process procedures is an effort to gather information about the benefits of a potential change in accounting; namely, to identify the most faithful way to present information about a transaction or economic condition so that investors and other users of financial statements can make well-informed decisions.

The FASB’s due process also involves collecting information about the costs of providing that new or different information. That includes the cost of understanding the requirements, developing systems to collect and process new information, the cost of training people, and the cost of auditing the information. The assessment of costs and benefits is an unavoidably subjective evaluation, because until investors have experience using that new information, the FASB's understanding of benefits is based on what they tell the FASB they need and how they will use the information. Likewise, until a company has actually adopted a new standard, the FASB's understanding of costs is based on imprecise estimates, even in a well-constructed and broad-based field test.

Nonetheless, throughout the process, the FASB uses a variety of techniques to gather robust data about both the expected benefits and the expected costs.

Full speech

© FASB